Search Energy Inc. is a rapidly growing oil and gas company. You have been

entrusted by your portfolio manager to evaluate Search Energy Inc. for

possible inclusion in the portfolio. As the company has been growing at a

very high rate in recent times, you have concluded that a two-stage dividend

discount model (DDM) is the most appropriate for valuing the stock. The

company's current stock price is $17 and it paid a dividend of $0.175 last

year. Search Energy Inc. has a beta of 0.84, the risk-free rate is 4.1%, and

the equity risk premium is 5.5%.

Required: Present all calculation step by step.

Estimate the value of the firm for each of the following approaches

separately:

a. The dividend growth rate will be 14% throughout the first stage of five

years. The dividend growth rate thereafter will be 7 percent.

b. In contrast to the first approach in which the growth rate declines

abruptly from 14% in the fifth year to 7% in the sixth, the growth rate

would decline linearly from 14 percent in the first year to 7 percent in

the sixth. (Hint: Use the H model)

c. What is your recommendation for Search Energy Inc. and why? What

is the implied growth rate at the current stock price assuming a

constant growth rate for the foreseeable future?